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Venture Capitalists may not be so good at stopping failing projects after all

My colleague, Isin Guler, has just published a fascinating study in one of our more erudite management journals. In an exhaustive look at investments made by venture capital companies, she finds that as funding rounds proceed, expected returns to the investment decline. You would think that a hard-nosed VC would just shut the loser down, wouldn’t you? Turns out, not so. In fact, the likelihood of a venture being terminated as a result of poor performance actually declines as more rounds of financing are completed. Isin (a professor at the University of North Carolina at Chapel Hill) suggests that political agendas, the desire to look good before one’s colleagues, a reluctance to admit defeat and giving too much weight to sunk costs all come into play.

It’s a sobering bit of research for those of us (myself among them) who have said that ruthlessly shutting down uncertain projects that don’t meet their goals is key to containing risk in uncertain investments. You also have to wonder – since VC’s are investment professionals, one might expect companies, in which far greater interference from the forces for escalation are likely to be prevalent – to be far worse at making the tough calls.

For those of you interested in the academic paper, the citation is:
Guler, I. 2007. Throwing good money after bad? Political and institutional influences on sequential decision making in the venture capital industry. Admin. Sci. Quart. 52(2) 248-285.